Debts, deficits and slow growth

Steven Kates

25 April 2013

I was given a copy of John Kenneth Galbraith's 1975 treatise which goes by the name of Money: Whence it Came, Where it Went. And there on pages 218-19 we find this:

‘Until Keynes, Say's Law had ruled in economics for more than a century. And the rule was no casual thing; to a remarkable degree acceptance of Say's Law was the test by which reputable economists were distinguished from the crackpots. Until late in the '30s no candidate for a Ph.D. at a major American university who spoke seriously about a shortage of purchasing power as a cause of recession could be passed. He saw only the surface of things, was unworthy of the company of scholars. Say's Law stands as the most distinguished example of the stability of economic ideas, including when they are wrong.’

Well let me say three things about this. The first is that the initial statement is absolutely right. Before the Keynesian Revolution, denial of the validity of Say's Law placed an economist amongst the crackpots, people with no idea whatsoever about how an economy works. That the vast majority of the economics profession today would have been classified as crackpots in the 1930s and before is just how it is.

And what did it mean to believe in Say’s Law? It meant that since we live in an exchange economy, although the existence of money tends to obscure the process by which demand is created by supply, the only way money can actually contain purchasing power is if the money one holds had been received in exchange for having sold something to others. I produce and receive money by selling what I have, which includes my labour time. Others receive their money for doing exactly the same. Therefore when each of us buys, we are actually exchanging the value of what we had each produced.

Deficit financing, on the other hand, creates money to spend without first bothering to produce the goods and services the money is supposed to represent. Since this fake money is identical to the real thing, its existence first dilutes the value of money. And then, secondly, because this money is always spent by governments in the first instance, the pattern of production is changed from what the market prefers to what the government prefers, which inevitably lowers the productivity of the economy. Debt, deficits and slow growth are therefore inevitable.

Secondly, Galbraith not only doesn't understand the meaning of Say's Law, he doesn't even understand Keynes. The one thing that both the classical side and Keynes agreed on was that a shortage of purchasing power is never the cause of recession. It is not whether people have the purchasing power that is at issue, but whether they spend it. That is why saving is such a major issue in the Keynesian model. People could spend their money but choose not to. It is never argued that they never had the money in the first place which was not the issue of Say's Law either. How incredible it is, not to mention disgraceful, that one of the leading Keynesians of his time had no idea of one of the fundamental ideas behind The General Theory.

Thirdly, if we are looking for some crackpot notion that stands as a truly distinguished example of the stability of economic ideas, including when they are wrong, there is virtually nothing in the history of ideas quite as incredible as Keynesian economics itself. Inane to the point of vacuity, destructive of prosperity on every occasion it has been applied, utterly useless as a guide to policy, Keynesian economics is the ultimate in crackpot ideas that stay long past their welcome in spite of every form of evidence that it is entirely mistaken about how an economy works and what needs to be done when recessions occur.

Steven Kates uses extremist language above so presumably I can do the same.
First, the idea that a non-entity like Kates can demolish two of the intellectual giants of 20th century, Keynes and Galbraith, in a few hundred words is truly hilarious. This is like a mentally retarded snail criticising Einstein’s theory of relativity.
Second, Kates claims, “the only way money can actually contain purchasing power is if the money one holds had been received in exchange for having sold something to others”. Well that’s just a joke.
Suppose the currency is gold. I go gold panning and get some gold. Now who have I “sold something to” in order to obtain the gold? No one!!!!
Same goes for £20 notes: their initial production PRECEDES the first occasion on which they are used to buy anything.
As for Kates’s description of Keyes’s ideas as “crackpot” and “inane” in the final paragraph (with no reasons given), my response to Kates is: “get lost”.
Please, please: I want to know. . . how do I get to write articles for the IEA? By having half my grey matter surgically removed so as to reduce my IQ to that of a chimpanzee?

Submitted by Philip on Thu, 25/04/2013 - 20:58.

@Ralph - a first criterion for writing for the IEA would be to read what others write in order to be able to make reasoned arguments. Kates does not call Keynes crackpot and inane but Keynesian economics crackpot and inane quite clearly using this as a rhetorical device given Galbraith's own use of the phrase. Keynes was really rather nuanced about the importance of his ideas - hence the comment "when the facts change, I change my mind, what do you do?". Few serious Keynes scholars would argue that Keynes would be at one with the naive Keynesians who followed him and it is not even clear that Keynes would have supported Keynesian policies to get out of the great depression. More sophisticated new-Keynesians understand this which is why they model rigidities identified by Keynes explicitly rather than simply relying on aggregate demand type models. Secondly, with regard to your gold panning argument, you are simply providing a different example of Kate's described mechanism. Creation of new money without new goods will lead to a reduction in the value of that money. Of course, the way it feeds through into the economy is different if the currency is gold and more gold is discovered. Thirdly, by no measure can Galbraith be described as an intellectual giant. Keynes yes, even though I think his style confused rather than clarified economic debate, Galbraith, no.

I’m fascinated by the idea that any significant number of present day Keynsians would not have used Keynsian type stimulus in the current recession. I’ve never seen any present day Keynsian suggest that. But I’m always open to persuasion. Do you have any articles or papers I can look at?
Re your claim that Kates in using the word “crackpot” was just repeating Galbraith’s terminology, that’s a fair enough point. I didn’t spot that. On the other hand, Kates did introduce the word “inane”.
Re “rigidities”, Keynes (and indeed anyone with some common sense) is aware that the labour market and economy in general contains rigidities. In fact it was Keynes who pointed to a major rigidity, namely that “wages are sticky downwards”.
However, the mere existence of rigities is not a reason to abandon Keynsian type stimulus in a recession. If one can show that those rigidities suddenly become much worse in a recession (an idea I find bizarre) then that might be a reason to abandon K type stimulus. But a reasonable assumption is that the rigidities remain more or less constant, in which case K’s ideas on stimulus are not degraded by such rigities.
Re your claim that “Creation of new money without new goods will lead to a reduction in the value of that money.”, not even Kates would agree with that (and quite right). As Kates pointed out, it’s the SPENDING of money or new money that is inflationary, not its mere production. Incidentally that’s a point which David Hume tumbled to in his essay “On Money” about 200 years ago.

Submitted by Philip on Fri, 26/04/2013 - 11:35.

re "creation" versus, "spending" - yes an imprecision there (but an important one given the discussion).
Regarding Keynes and the Keynesians, what I am saying really is not how you put it.
1. Keynes view would be quite nuanced on "Keynesian stimulus". This was even so after the publication of general theory (after all, by that time, monetary stimulus had got us out of the depression quite dramatically and he said that could not happen). We do not know what he would have said today with an already high fiscal deficit, quite high employment and low productivity growth - these are not "1929-1932" type problems.
2. However, it is unlikely that he would have followed some of the post-war naive Keynesians (Peston, Lipsey, Krugman).
3. Modern "new Keynesians" tend to model the rigidities that Keynes talked about explicitly (which Peston, Lipsey, Krugman et al never did/do). This does not stop some of them (eg Larrry Summers) calling for fiscal stimulus but others (eg John Taylor - who tends to use new-Keynesian/neo-classical models) disagree.
As it happens, we used a very good macro-economics book at university by Charles Baird which incorporated money holdings into Say's law. This was quite useful as it allows one to understand explicitly how one might deal with a strong demand to just hold liquidity. However, it also focused the mind on Say's law as an effective "truism" which, like the quantity theory of money can still teach us something. My mind is a bit fuzzy on this now.

Submitted by HJ on Sat, 27/04/2013 - 14:07.

Ralph Musgrove:
"“the only way money can actually contain purchasing power is if the money one holds had been received in exchange for having sold something to others”. Well that’s just a joke. Suppose the currency is gold. I go gold panning and get some gold. Now who have I “sold something to” in order to obtain the gold? No one!!!!"
The point is that the currency isn't gold - you'd have to extract and sell the gold in order to gain money to spend on something else. If, instead, you produced currency directly, then you would just be diluting the value of other money because you have increased the amount in circulation, so there has been no increase in overall purchasing power - you've merely stolen the value of money from other people, not created any value.

Submitted by HJ on Sat, 27/04/2013 - 14:17.

Incidentally, Philip, do you believe that there is really any such thing as a "good book on macroeconomics"? Hayek argued that "the artificial simplification necessary for macro-theory tends to conceal nearly all that really matters" in a piece in which he refers to Keynesianism leading to "the temporary obliteration of many important insights which we had already achieved". As a non-economist, Im inclined to agree with him but if you really can recommend a good book on macro-economics, I'd like to read it.
BTW, when were you at university (specifically Hatfield, I believe)? I wonder whether we were around at the same time (although I was a physicist and not at Hatfield).

HJ, You claim “If you produced currency directly, then you would just be diluting the value of other money..”.
You don’t seem to have read or understood my second comment above. As I pointed out there (and as David Kates and David Hume pointed out), the fact of printing more money as NOT NECESSARILY inflationary. It won’t be inflationary if the additional money is saved rather than spent.
Moreover, one can get a rise in inflation even with a CONSTANT money supply if the velocity of circulation of money rises. And velocity can change dramatically: in New York State, velocity in 1931 had dropped to a third its level in 1928. That's just another way of saying that in 1931 people were doing more saving than in 1928.

Submitted by HJ on Sun, 28/04/2013 - 20:22.

Ralph Musgrove - I was replying to your first comment. That's why I quoted from it. I also suggest that you read my comment which made a perfectly valid point. Extracting gold adds value through the availability of more gold. If I print money and put it under the mattress, then, of course, while it is under the mattress it makes no difference (its as I had never printed it). However, once I do something with it (spend it or put it in the bank for them to lend out) then it does make a difference.

Submitted by Philip on Sun, 28/04/2013 - 22:16.

HJ - frustratingly, just replied to your question at great length and then something went wrong and I lost it! I was at Hatfield 1982-1985. Where were you when? The Baird book is good. We also used Dornbusch and Fischer. Effectively they are new-Keynesian but I have a lot of time for this way of thinking as they analyse rigidities etc explicitly and drill down to the micro-economics of macro-economics (and for that reason, we did not call it macro at Durham). There is also Kates' book Free Market Economics. Lipsey (1982 edition) was hopelessly dismissive of the more sophisticated ways of thinking about macro (see my chapter in Were 364 economists all wrong).

Submitted by HJ on Tue, 30/04/2013 - 12:28.

Philip - Thanks, I will look for those books. Sorry you went to such trouble only to see the wonders of modern technology defeat your efforts. I was at Castle from '79 to '82, so we overlapped by a year.
My prof., Gareth Roberts, was a member of Hatfield, I believe. Rather annoyingly, people like you rather challenge my prejudices about Hatfield being full of beer-swilling rugger buggers!

Submitted by philip on Tue, 30/04/2013 - 13:38.

well, in fact Hild and Bede was my first choice. But Hatfield was a fairly diverse college (partly because of involuntary transfers, I guess). Huge Christian Union and membership of the Cathsoc, large number of Tory members and a few rugby players. I certainly do not regret my time there and was pleased to have been transferred. Gareth Roberts rings a bell but not a very loud one. I got on very well with my personal tutor Dr. Larwood who was a staunch SDP member.

Submitted by HJ on Tue, 30/04/2013 - 14:48.

Philip - Do you ever go back for college reunions? I've been to a couple of Castle ones and they are immense fun. Last time I 'broke into' (in fact it was prearranged) the college boat house and went out in a single scull - my first time on the Wear for 30 years. Many of the serving staff were still there - it was really nice to sit down with them after meals to chat. I too have very happy memories of Castle and who'd have predicted where some people ended up, especially George Entwistle whom I remember.
I remember that Cathsoc had a huge membership, many of them not even catholics, on account of the excellent social life. The president of Cathsoc had the room next to mine in the 3rd year - there seemed to be a constant stream of visitors. How he got any work done, I'll never know. My personal tutor, also known as our 'moral tutor' (as opposed to departmental subject tutors) was Dr Flowers who told us straight away "I'm not much interested in your moral problems unless they're really interesting ones!". He was a tremendously nice chap who plied us with a range of sherries and it was there that my lifelong love of sherry began (Sherry is perhaps the world's least understood and appreciated wine).

Submitted by philip on Tue, 30/04/2013 - 16:32.

Good story about Dr Flowers. I am afraid i do not go back for reunions. I do like the place and went a lot when I fought the Houghton and Washington seat in 1997 and then again for a little holiday in 2008 I think. I will be going again in May to see some academics there.

Submitted by Eric on Wed, 08/05/2013 - 12:41.

oh dear. not much going on here (apart from rhetoric masquerading as academia). Please remember, in the long term we are all dead!

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